Adams, Gwyn, Lewis Alexander, and Joseph Gagnon, “German Unification and the European Monetary System: A Quantitative Analysis,” International Finance Discussion Paper Number 421, Board of Governors of the Federal Reserve System, January 1992.
De Gregorio, José, Alberto Gionvannini, and Holger C. Wolf, “International Evidence on Tradables and Nontradables Inflation,” IMF Working Paper WP/94/33, March 1994 (to be published in the European Economic Review).
Deutsche Bundesbank, “Real Exchange Rates as an Indicator of International Competitiveness,” Monthly Report. Vol. 46, No. 5, May 1994.
Feldman Robert A., “Trends and Determining Factors of the External Value of the Deutsche Mark,” Monthly Report, Vol. 45, No. 11, November 1993.
Golub, Stephen S., “Comparative Advantage, Exchange Rates, and G-7 Sectoral Trade Balances,” IMF Working Paper WP/94/5, January 1994.
Knetter, Michael M., “Price Discrimination by U.S. and German Exporters,” American Economic Review. Vol. 79, No. 1, March 1989, pp. 198–210.
Lipschitz, Leslie and Donough McDonald, “Real Exchange Rates and Competitiveness: A Clarification of Concepts, and Some Measurements for Europe,” IMF Working Paper WP/91/25, March 1991.
Marsh, Ian W., and Stephen P. Tokarick, “Competitiveness Indicators: A Theoretical and Empirical Assessment,” IMF Working Paper WP/94/29, March 1994.
Masson, Paul R., Steven Symansky, and Guy Meredith, “MULTIMOD Mark II: A Revised and Extended Model,” Occasional Paper 71, International Monetary Fund, July 1990.
Masson, Paul R., Steven Symansky, and Guy Meredith, “Domestic and International Macroeconomic Consequences of German Unification,” in German Unification: Economic Issues. Occasional Paper 75, International Monetary Fund, December 1990.
Turner, Philip and Jozef Van't dack, “Measuring International Price and Cost Competitiveness,” BIS Economic Papers, No. 39, November 1993.
Wickham, Peter, “A Cautionary Note on the Use of Exchange Rate Indicators,” IMF Paper on Policy Analysis and Assessment, PPAA/93/5, March 1993.
I would like to thank Jacques Artus, Robert Corker, Mohsin Khan, Manmohan Kumar, Tessa van der Willigen, and Harilaos Vittas for helpful discussion and suggestions. Aarne Dimanlig, Toh Kuan and Rosa Vera-Bunge provided valuable research assistance. Any errors, however, are my own.
See Masson and Meredith (1990), and Adams and others (1992). It might be noted that the analysis in both of these papers suggested that some real depreciation of the deutsche mark would later be prompted by the withdrawal of stimulus related to the earlier unification shock.
It is evident that measures of international competitiveness by themselves cannot be taken as measures of economic well-being and that the goal of economic policy is not to achieve a particular target for performance in the traded goods sector. Rather, policies should be aimed directly at promoting appropriately high and sustainable rates of savings and investment, correspondingly high productivity and economic growth, and thereby, an improved standard of living; factors that may also have a positive impact on a country's ability to compete in international markets. Several articles by Paul Krugman discuss the misuse of the notion of international competitiveness as an underlying reason for economic difficulties that are primarily domestic in origin. Just three examples are Krugman (March/April 1994, February 1994, and November 1991).
The strategy of defending market share through squeezing profits is not one that can be sustained in the long run--thus the argument that indicators based on relative costs, whether unit labor costs or more comprehensive measures of costs discussed later, are particularly relevant for assessing external competitiveness from a longer-term perspective.
Lipschitz and McDonald (1991) offer evidence that profit margins in the ERM countries increased relative to those in Germany up to 1988.
It is important to note that the later part of the 1980s witnessed a large fall in the price of oil. While this would have been of benefit to both domestic and foreign exporters' profit margins, the benefit to Germany was probably more pronounced because of greater reliance on imported oil than many other industrial countries. Nevertheless, comparing the index based on unit labor costs to one based on value-added deflators in manufacturing instead of export unit values still indicates declining relative profit margins, particularly later in the 1980s (Chart 2).
Much of this section draws on Bundesbank, Monthly Report (May 1994), pp. 45-57.
To emphasize this point, the Bundesbank notes: “Although labor costs--in terms of the value added--constitute by far the most significant cost factor in the manufacturing sector, with a share of 70 percent, in relation to the total value of the finished product (in other words, including the intermediate work undertaken by other domestic sectors and by sectors abroad) the labor costs incurred directly in manufacturing account for only about one-quarter of the total.” See Bundesbank, Monthly Report. (May 1994), p. 51.
As is well known, there are other difficulties associated with using data on unit labor costs. Changes in the prices of inputs other than labor affect competitiveness, but are not captured by examining only unit labor costs. For example, the substitution of capital for labor may result in a lower unit labor cost index but higher capital costs, so the decline in unit labor costs overstates any improvement in cost competitiveness. In the process, labor may be reduced, and more importantly some marginal activities, typically where productivity is relatively low, would cease altogether. It may in fact be a lack of competitiveness that causes the output of tradables to fall but that also results in a rise in average productivity. More detailed discussion of these difficulties, as well as of more general difficulties with measures of real exchange rates, is found in Lipschitz and McDonald (1991), Turner and Van't dack (1993), Wickham (1993), and Marsh and Tokarick (1994).
Marsh and Tokarick (1994) suggest that export volume equations using competitiveness indicators based on unit labor costs (normalized) can explain trade flows for exports of goods overall, and for manufactured goods alone, somewhat better than indicators based on consumer prices or export unit values.
If prices of traded goods in different countries are closely related through international competition, then a real appreciation of the currency as measured by aggregate price indices would suggest that developments in the internal terms of trade are more favorable to nontraded goods in the appreciating country.
Underlying this adjustment is the idea that the internal real exchange rate represents the domestic cost of consuming and producing tradable goods, and is a summary measure of the incentives guiding resource allocation between the two major sectors of the economy.
The data used to construct these variables are available through 1991 and are from the OECD international sectoral database, comprising 14 countries and 20 sectors. Tradables are defined to include those sectors in which more than 10 percent of total production is exported for all 14 countries combined. For details on this database and classification, see De Gregorio and others, WP/94/33 (March 1994). The data used here update their calculations for 1970-85 up to 1991.
De Gregorio et al. (1994) provide evidence of the increase in the relative price of nontradables for 14 OECD countries, using the OECD international sectoral database.
Reversing the order of calculating effects (2) and (3) would give a different decomposition, but not change the calculations of their combined effects.
A considerable bias might have been introduced in the interpretation of the competitiveness residual had the German economy been growing at a significantly different rate than the OECD average. In fact, real growth in west Germany, and for the OECD overall, averaged around 2 1/2 percent from 1980 to 1992.
While it would have been desirable to also perform the analyses on volume data to try to control for valuation effects, such data are not available.
The 11 market groupings are: North America; Japan; Australia, New Zealand, and South Africa; the 12 EU countries; EFTA; Asia; Africa; Latin America and the Caribbean; the Middle East; the economies in transition; and others not classified elsewhere, or a residual market. The one-digit SITC classification is: section 0 for food and live animals; section 1 for beverages and tobacco; section 2 for crude materials, inedible, except fuels; section 3 for mineral fuels, lubricants and related materials; section 4 for animal and vegetable oils, fats and waxes; section 5 for chemicals and related products; section 6 for manufactured goods classified chiefly by material; section 7 for machinery and transport equipment; section 8 for miscellaneous manufactured articles; and section 9 for commodities and transactions not classified elsewhere.
The elasticities estimated by the Bundesbank (May 1994) for various measures of the real exchange rate are groups (in absolute value) at 0.3 or lower in the short-run, and below 0.5 in the long-run. Golub (1994) finds comparatively little responsiveness of German exports to changes in relative unit labor costs. These two studies do not report income elasticities.
The combined effect for the 1987-88 period alone was virtugroupsy zero.
Estimates from MULTIMOD, the IMF's multicountry macroeconometric model would suggest that most of the effects take place in one year. But even groupsowing for longer lags, say up to three years, would fail to explain the positive competitiveness residuals that the calculations suggest for the 1991-92 period.
To be clear, this analysis focuses only on profits in Germany whereas the discussion in Section II.1 is in terms of German profits relative to competitor countries. It would appear from the data in Table 5 that the apparent decline in Germany's relative profit margins up to 1990 did not reflect extensive pressure on absolute profits margins at home.
While detailed data are available only through 1991, the Bundesbank in its Monthly Review (November 1993) reports a loss of profitability in 1992.
German exporters have recently recorded rapid growth in their trade with developing countries, particularly in the Latin American and Asian regions. It appears that Germany has gained a stronger foothold in the Asia region and is increasing its export marketing efforts there, helped by improved competitiveness against Japanese producers because of the strength of the Japanese yen.
The spring wage round produced settlements typicgroupsy in the 0-2 percent range, in addition to agreements to increase the flexibility of labor utilization.
Export data for 1993 are subject to revision as the changeover to a new system of recording trade between EU countries (INTRASTAT) may have resulted in an underestimation of German exports to these countries.